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Going nowhere: Economy struggles to find footing

A trader work on the floor of the New York Stock Exchange on Wednesday, Aug. 3, 2011, in New York. With no clear sign of what will invigorate growth, there is mounting fear on Wall Street that the U.S. risks sliding into a long-term economic coma. (AP Photo/Jin Lee)

Without much to invigorate growth, the economy may be in danger of slipping into a stupor like the one Japan has failed to shake off for more than a decade. And Wall Street is spooked.

The Dow Jones industrial average Wednesday barely broke an eight-day losing streak, finishing up about 30 points. A nine-day losing streak would have been the Dow's first since February 1978.

Even with the gain, the Dow has fallen 828 points, or 6.5 percent, over the past nine trading days. Investors didn't even pause to celebrate the resolution over the weekend of a dangerous debt standoff in Washington.

Stunned by news last week that the economy barely grew in the first half of 2011, economists are lowering their forecasts for the full year and recalculating the odds that the economy will slide back into recession.

Kurt Karl, chief U.S. economist at Swiss Re, has cut his 2011 forecast for growth this year to 1.8 percent from 2.6 percent. And he has bumped up the likelihood of another recession to 20 percent from 15 percent.

"The last week has made it much more likely that corporate profit estimates will be revised lower," said Nick Kalivas, a vice president of financial research at MF Global.

The stocks that have fallen the furthest have been those of companies that fare best in economic expansions. Industrial companies like Caterpillar and Boeing, energy companies like Exxon Mobil and Chevron, and retailers like Amazon and Coach have all fallen by more than the broader stock market.

Investors have pushed government bond yields to their lowest level of the year. The 10-year Treasury note now yields 2.6 percent. Bond yields typically fall when the economy is weak because nervous investors view bonds as a safe place to park their money, and there's less chance that inflation will erode their value.

The economy started sputtering early in the year. Economists at first thought the slowdown would be temporary, the result of a short-term rise in gasoline prices and an earthquake in Japan that disrupted shipments of auto parts and electronics.

But the weakness persisted. And it worsened as a political fight over debt and deficits raised the risk that the U.S. government would not be able to pay all its bills.

"It now seems fairly clear that those shocks have done a lot more damage than we expected," says Leo Abruzzese, global forecasting director for the Economist Intelligence Unit. "They seem to have had a devastating effect on confidence."

After the government reported that the economy grew at an annual pace of 0.4 percent in the first quarter and 1.3 percent in the second, Abruzzese is cutting his estimate for 2011 growth from 2.4 percent to less than 2 percent.

It's hard to see anything lifting growth to the 2.5 percent needed to keep unemployment from rising, let alone the 5 percent needed to bring the rate down significantly from June's 9.2 percent.

"Sales are what keeps the market moving higher, and there's not much demand when there's only 0.4 percent growth," said Andrew Goldberg, U.S. market strategist at JP Morgan Funds.

When the economy grows less than 2 percent over a 12-month period, it risks slipping into recession, says Mark Vitner, senior economist at Wells Fargo Securities. Over the most recent such period, the economy grew just 1.6 percent.

Few economists are predicting another recession, despite a series of weak economic reports. Gasoline prices have come down from their high of almost $4 a gallon in May. And Japanese factories are starting to crank up again after the March earthquake.

At the heart of the economy's problems are the debts that consumers built up during the early and mid-2000s. Many borrowed against the equity in their homes, convinced that house prices would rise forever.

When housing prices collapsed, people were left owing more than their homes were worth. Others charged up their credit cards. Now it's payback time, and Americans are spending less or spending cautiously as they slash their debts.

Companies are reluctant to hire until they're convinced enough customers are ready to buy their products or services. Corporate profits are booming, though, because companies laid off millions of workers, learned to operate more efficiently with smaller staffs and expanded in growing markets overseas.

"If companies were inclined to hire, they could," Abruzzese says.

So companies are waiting for consumers to spend, and consumers are waiting for companies to hire them or offer generous pay raises and job security. It's a tough cycle to break.

In the past, the government has helped by spending on infrastructure projects or jobs programs. This time, it's cutting at all levels. In the second quarter, government cutbacks reduced economic growth by 0.2 percentage points.

More cuts are coming. The deal to raise the debt limit calls for $917 billion in federal spending cuts. Those won't do much immediate damage to the economy because they mostly kick in after 2013, but a special congressional committee is supposed to find at least another $1.2 trillion in savings over the next decade, and no one knows where the ax will fall.

"You're not sure if there are going to be huge spending cuts or tax increases. Or are they just going to wrangle?" Swiss Re economist Karl says. "If you're a supplier to any part of the government, you certainly are not rushing to hire people or buy equipment. There's definitely a damper on growth."

To some economists, the United States is starting to look eerily like Japan. The Japanese economy fell into a recession in the early '90s. It has never fully returned to health, largely because of policy mistakes. The government raised taxes after declaring victory over the downturn prematurely. And U.S. economists, including current Fed Chairman Ben Bernanke, criticized the Japanese central bank, the Bank of Japan, for being too passive to turn the economy around.

The Fed has kept short-term interest rates near zero since December 2008 to stimulate the economy. But at the end of June, it ended a $600 billion program to buy government bonds and keep long-term rates — the ones that determine the rates people pay on cars and houses — low.

It was the second round of what economists call quantitative easing, or QE2 for short. But the Fed has no plans for a third, fearing it would lead to higher inflation.

Kenneth Rogoff, a Harvard University economist, says that in this economy, QE3 — and, if necessary, QE4 and beyond — is the only hope.

"Yes, we are starting to look like Japan," he says. "But it is not too late."

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Randall reported from New York.

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